Apr 09, 2011 (LBO) - A dollar peg in the Maldives which is coming under pressure from excess domestic money has hit the airline business and also cut the real wages of expatriate workers, a media report said.

Minivan News an online publication said Galaxy Enterprises which is the general sales agent for SriLankan Airlines has stopped selling tickets and referred customers to the airlines website, due to foreign exchange shortages.

Foreign exchange shortages happen when a monetary authority tries to maintain a peg, after printing money beyond its dollar purchases.

To sustain a peg, a monetary authority has to create local money (rufiyaa in the case of Maldives) only by purchasing foreign currency. This matches the domestic money supply with foreign reserves exactly.

However if a monetary authority buys government treasury bills and prints additional money beyond the net dollar inflows, either to lower interest rates or to finance government expenditure, the additional domestic money will pressure the peg.

Economists call the problem the 'impossible' trinity of monetary policy objectives. A central bank that tries to target the interest rate by printing money cannot also maintain a fixed exchange rate and allow the free flow of foreign currency out of the country.

If the monetary authority prevents the exchange rate peg from breaking and adjusting to the expanded money supply it will have to ration supply or impose exchange controls.

Outside the controlled banking system the rationing will happen through the creation of a 'black market'.

In the black market prices will rise and less dollars will flow out than at the official 'controlled' rate. Black markets are automatic responses by the economy to state imposed price controls.

The Minivan News report said the black market rate is 16 rufiya to the dollar, compared to the 'official' rate of 12.75 to the US dollar.

The report said many of the country's 100,000 foreign workers (especially a large number of labourers from Bangladesh) are paid in rufiyaa by their employers and are forced to buy dollars from the black market at high prices.

The report said police helped by the Maldives Monetary Authority are 'cracking down' on black marketers. Such knee jerk reactions are also common in all countries with loose monetary policy.

The report quoted Tyronne Soza, Maldives Country Manager for Mack Air Services Maldives, a unit of Sri Lanka's John Keells Holdings, which represents Jet Airways and Mihin Air as saying that the dollar dollar supply was a major concern.

"We are having some issues with obtaining and paying in dollars right now, the report quoted Soza as saying.

"As we are part of the John Keells group we have been able to manage the situation though. It’s illegal to charge customers in dollars and obviously we accept rufiya, but it is difficult."

A state usually forces people to use bad money (either high inflation or non-convertible money) through a 'legal tender' law which creates a money monopoly and criminalizes the use of a better money by people to protect their hard earned savings.

When a central bank creates very high rates of inflation and currency depreciation people will ignore such rules and simply use foreign currency, a process known as 'dollarization'.

After a bout of hyperinflation, Zimbabwe has legalized foreign currency and several central banks now compete for people's confidence and the country is official dollarized with multiple currencies ending the coercive money monopoly.